Month: July 2013

The Indian government has doubled the price for gas, turning a relatively cheap fuel into an expensive one, overnight. This price change will kick in from 2014 but there is considerable cause for worry over this harakiri by the United Progressive Alliance (UPA) government. This revision of gas prices is being billed as part of the ‘reforms’ process and a section of corporate India is upbeat. The reality is very different. It may send the economy haywire and leave a mess for the next government.

Raising the gas price will lead to an increase fuel and power costs across the board. Companies that use gas to power their plants, will have to pay much more for it. This will lead to an increase in their production cost, which in turn will destroy their competitiveness in the local and the overseas market. China continues to flood the Indian market with their inexpensively produced goods in every industry including electrical and electronics, mechanical and metallurgical products, chemicals, glass and ceramics-based products.

In the export market too, Indian companies find it an uphill task to compete with Chinese manufacturers because of the higher production
cost in India. The higher cost is due to several factors including corruption, poor infrastructure, fuel costs, compliance costs etc. Raising the gas bill will only damage this competitiveness further. Reduced profitability may lead to layoffs and harm employment generation in such industries. This in turn can reduce discretionary purchasing power in the hands of the people due to pay cuts and job losses. The price of foodgrains and other commodities will move up because transportation costs will increase. Transportation costs are a significant component in case of many commodities especially foodgrains. All around inflation will increase and further reduce purchasing power.

One factor that stands out here is that the price the government will pay has been determined while the price the consumers will pay has yet
to be determined. This is being played up the government but it means little. The government will have to pick from either charging the entire sum to the consumer or subsidizing it. If Are the government does away with subsidies, the gas and fuel prices will increase the price of everything leading to all
around inflation. If they choose to subsidize it, the subsidy will have to come out of the tax collections, which the citizens will pay. The government may
have to raise taxes so that they can afford to pay the increased tax bill. So, not only are jobs and profits of the corporates on the line but an increase in direct and indirect taxes is almost certain.

In any case, the economy will be affected. Subsidies do not usually make sense because they take money Jersey away directly. Had there been no subsidies, the citizens would have some more purchasing power left which they would have used their discretion to spend. Subsidies can be useful only if they are used to ensure equitable distribution of wealth, transferring wealth from those who have the most to those who need it the most. This rarely happens especially in India where there are too many leaks in the system.

Another factor is that the price of gas has been fixed in dollars while the amounts collected from the consumers will be in rupees. The government will either have to hedge its position given the huge foreign exchange risk or, more likely, bear the risk. If the dollar goes up it will increase the liability. Agreeing to a dollar rate especially when dealing with Indian gas producers like Reliance Industries seems unnecessary.

Since the gas prices will harm the economy and increase the production cost of local industries, making them less competitive, we can expect exports to be affected. If exports reduce, the deficit will widen because India will be exporting less and importing more. The dollar will move up against the rupee. This in turn will increase our liability for gas in rupee terms. That will further harm our local purchasing power and industry.

So, we are heading down a slippery slope here.

To take care of the fiscal deficit, the government hopes to sell stakes in some public sector units (PSUs). There are two flaws here. One is that the stock market is unlikely to remain buoyant if the economy starts going downhill. The other is that this is similar to selling your house furniture and car to pay your monthly credit card bill. The response to these PSU sales have been much below expectations over the past couple of years. Several stock offerings from PSUs such as ONGC and SAIL have had to be postponed due to poor market conditions. When they have come out with offers for sale, the pricing has been much lower than the government would have liked.

India’s external debt has balooned over the years. It is now $390 billion dollars in 2013, up from about $100 billion in 2004. That’s close to a four fold increase in nine years and compounded growth of over 16.5% every year. The short term debt payable is $172 billion up from $54 billion in 2008. India
has to pay back $172 billion to foreign investors by 2014.

That the confidence of foreign instituitional investors in the Indian economy is flagging is shown by the heavy selling in debt all oflast month. There was such heavy selling in Indian government’s bonds that trading had to be halted due to the decline in a single session crossing a threshold. Indian bonds
had dipped after the US Fed unveiled its policy.

The stock market has been falling consistently. The BSE sensex and the NSE Nifty 50 are held up only by some of the component companies of
the respective indexes. Small cap and mid cap stocks have declined across the board. Investors have been shying away from stocks with most having seen a negative or no return since 2008 on their investments while interest rates have been at a high indicating a higher opportunity cost. Initial public
offers by companies have resulted in stocks trading at one tenth of the issue price post-listing in many cases. There are allegations of serious financial mismanagement and fraud by companies raising public money. This has led to Securties and Exchange Board of India (SEBI) launching investigations in many cases. Bombay Stock Exchange (BSE) has introduced periodic call auction system at the behest of SEBI which has led to volumes drying up in the counters of smaller companies. Such a situation affects the capital raising ability of companies and their expansion plans, something that is very detrimental because small and coming medium enterprises create a lot of employment. There are more than one million engineers this year in India who will have no jobs largely because the SME sector remains ignored.

Standard and Poor, the international rating agency recently reiterated their negative rating on India. This is one level above ‘junk’ If the rating is revised down to junk, it will worsen India’s situation as debt will be harder and more expensive. It will also send the rupee further down as many investors will exit India.

A lot of Indian politicians have been too busy battling scams and corruption scandals to manage the economy effectively. As a result, India’s GDP growth has been declining. A lot needs to be done to get India back on the growth track. Corruption remains one of India’s biggest troubles. Due to a corrupt system, the amounts spent on infrastructure and development are disproportionately high as compared to the final outcome, expanding the deficit considerably. The gas pricing policy needs to be relooked at. The SME sector has to be stimulated with special incentives for export oriented companies and the companies that will be able to compete with China. Compliance costs and red tape have to be reduced. Smaller companies should have an easier environment to raise equity or debt in. Without these measures being taken, a recession is imminent.